legal notes: THE LEGAL SIDE OF ABL & FACTORING

he cases we have selected for this issue address the bankruptcy court's authority to cap credit bids for cause, the sale of distressed loans to eligible assignees and fiduciary duties of an equityholder that may arise from its additional role as a senior secured creditor.

In re Free Lance-Star Publishing Co. of Fredericksburg, VA, Case No. 1430315-KRH (Bankr. E.D. Va. Apr. 14, 2014) (Bankruptcy court holds that a secured creditor's right to credit bid in a §363 sale can be capped for cause due to its aggressive loan-to-own strategy.)

Free Lance-Star Publishing Co. of Fredericksburg, VA is a family-owned company engaged in publishing, newspaper and radio communications. In connection with an expansion of its commercial printing operations in 2006, Free Lance borrowed $50.8 million from Branch Banking and Trust and constructed a state-of-the-art printing facility. To secure this loan, Free Lance granted liens on certain of its real and personal property. However, three parcels of real property and related assets used for radio broadcasting operations (the "Tower Assets") were specifically excluded from the collateral package. By 2009, Free Lance was in default under the BB&T loan facility and the parties negotiated a forbearance agreement in an attempt to restructure the loans. Free Lance continued to make payments under the loan, but the parties were unable to agree on a long-term restructure. In June 2013, BB&T sold the loan to DSP Acquisition, LLC, a subsidiary of Sandton Capital Partners, LLC.

In July 2013, Sandton informed Free Lance that it wanted Free Lance to file a Chapter 11 bankruptcy case and sell substantially all of its assets to DSP in a § 363 sale. At the same time, Sandton requested that the Free Lance execute deeds of trust to encumber the Tower Assets in advance of that filing. The parties were unable to come to an agreement and, unknown to Free Lance, DSP unilaterally filed UCC fixture financing statements against the Tower Assets. Ninety days after filing these financing statements, DSP stepped up its pressure on Free Lance for a fast bankruptcy and expedited sale process. Free Lance engaged Protiviti, Inc. as a financial consultant to assist with the sale. Sandton objected to the Protiviti's engagement and, among other contested items, insisted that Protiviti's marketing materials conspicuously highlight DSP's right to credit bid the full S39 million amount of its outstanding claim. The parties also disagreed on Protiviti's financial projections, which Sandton argued were too optimistic, and on whether a post-petition DIP loan facility would be required. Without the DIP facility, Sandton would not receive liens on the Tower Assets. Ultimately, negotiations among Free Lance, Sandton and Protiviti completely broke down and Free Lance filed its bankruptcy case, without the support of its secured lender, in January 2014. A §363 sale was scheduled, and DSP sought to credit bid the full amount of its claim in the sale.

Under §363 of the Bankruptcy Code, a creditor is generally entitled to credit bid the full amount of its claim unless the court "for cause orders otherwise." The court analyzed this provision through the lens of the underlying policy of the Bankruptcy Code and noted that credit bidding is an important safeguard to protect against undervaluation of a creditor's collateral. However, credit bidding is notan absolute right. In the widely covered Philadelphia Newspapers case (In re Philadelphia Newspapers, LLC, 599 F.3d 298 (3d Cir. 2010)), the U.S. Court of Appeals for the Third Circuit held that a court may deny "the right to credit bid in the interest of any policy advanced by the [Bankruptcy] Code, such as to ensure the success of the reorganization or to foster a competitive bidding environment." Id., at 31516. Further, in In re Fisker Automotive Holdings, Inc., 2014 WL 210593 (Bankr. D. Del. Jan. 17, 2014), a recent case that we reported on in The Secured Lender, a bankruptcy court held that "cause" existed to deny the right to credit bid where a secured lender "chilled the bidding process by inequitably pushing the debtor into bankruptcy so that it could short-circuit the bankruptcy process." Id., at *17.

In this case, DSP argued that it should be entitled to credit bid the full $39 million face value of its debt. Free Lance argued that DSP's credit bid should be limited because (i) DSP did not have a lien on all of the debtor's assets, (ii) DSP had engaged in inequitable conduct that "damped interest" in the auction and depressed the potential sales price and (iii) limiting the credit bid would foster a "robust bidding process" to maximize recovery for all creditors in accordance with policy intentions of the Bankruptcy Code. The court agreed with Free Lance and limited DSP's credit bid to $1.2 million for assets related to the radio business on which DSP had valid liens and $12.7 million for assets related to the printing business. First, the court held that DSP was, in fact, less than fully-secured. Next, in describing Sandton's and DSP's approach as an "overly zealous loan-to-own strategy," the court concluded that they had engaged in inequitable conduct. The court viewed Sandton's motivation to own the business, rather than to have the loans repaid, as interfering with the sales process. Moreover, the court believed Sandton was intentionally seeking to depress enthusiasm for a bankruptcy sale, and depress value of the estate, to the benefit of DSP at the expense of the estate's other stakeholders. As a result, the court held that sufficient cause existed to limit the credit bid in order to foster a robust and competitive bidding environment.

This case is an important reminder of a potential risk when purchasing distressed debt in a loan-to-own strategy. Combined with the recent Fisker case, it appears that courts may closely review the conduct and motives of the secured creditor under the "for cause" exception to limit credit bidding.

Meridian Sunrise Village, LLC v. NB Distressed Debt Investment Fund Ltd., etal, 2014 WL 909210 (Bankr. W.D. Wash. March 7, 2014) (Bankruptcy court holds that hedge funds that purchased distressed debt were not "Eligible Assignees" under the loan agreement.)

In 2008, Meridian Sunrise Village, LLC borrowed $75 million from a syndicate of lenders agented by U.S. Bank for the construction of a shopping center. The loan agreement included general limitations on each lender's ability to assign its loan to other entities. Specifically, no lender was permitted to transfer all or any portion of its loan to any person other than an "Eligible Assignee," which was defined as "any Lender or any Affiliate of a Lender or any commercial bank, insurance company, financial institution or institutional lender approved by Agent in writing and, so long as there exists no Event of Default, approved by Borrower in writing, which approval shall not be unreasonably withheld." By 2012, Meridian was in default under the loan agreement and U.S. Bank requested that Meridian waive the eligible assignee restrictions to facilitate its exit from the loan. In exchange, U.S. Bank offered to forbear from charging default interest under the loan agreement, which was set at 20 percent of the loan's outstanding balance. Meridian refused to waive the transfer restrictions, claiming that it had negotiated the restrictions to specifically avoid future assignments to predatory investors who purchased distressed loans to obtain control of the collateral and liquidate for quick repayment. U.S. Bank instituted the default rate, which Meridian could not pay, and Meridian filed a Chapter 11 proceeding.

After the bankruptcy filing but prior to a vote on the plan of reorganization, Bank of America, N.A., which was another lender in the bank group, transferred its interest to NB Distressed Debt Limited Fund. NB assigned portions of its interest to two affiliated funds. In the bankruptcy proceeding, Meridian objected to Bank of America's transfer to NB and sought to enjoin the funds from exercising any rights under the loan agreement including, most importantly, voting on the plan of reorganization. Therefore, the issue before the court was whether the funds constituted "Eligible Assignees" under the plain meaning of the loan agreement.

The funds argued that the definition of "financial institution" was broad, even limitless, and should include any and all enterprises that specialize in the handling and investment of funds. Meridian argued that the text, and all parties' prior actions, made it clear that the credit agreement intended "financial institutions" to specifically exclude entities such as the funds.

The court agreed with Meridian, holding that the funds were not permitted to acquire the debt or vote on the plan of reorganization. First, the court stated that it was clear that the parties intended "financial institution" to be limiting. Under the funds' interpretation, an individual could form a company online with a business reason of managing loans and this "fly-by-night" entity would be free to acquire the loans. This, according to the court, could not have been the intent of the parties under the contract. Next, the court found that, when read in context, the term "financial institution" harmonizes with commercial bank, insurance company and institutional lender(the other terms used in the sentence) to mean "entities that make loans." The funds, although investment vehicles, were not in the business of making loans. Finally, the court was persuaded that extrinsic evidence from the parties' actions further supported a limited interpretation of "financial institution."

Lenders should take care when negotiating limitations on transferees in a loan agreement as courts will interpret the plain meaning of the contract, and this may impact a lender's ability to sell its loans to purchasers of distressed debt.

Hamilton Partners, L.P. v. Highland Capital Mgmt., 2014 WL 1813340 (Del. Ch, May 7, 2014) (Delaware chancery court holds that a 48% minority shareholder may owe fiduciary duties to other shareholders as a result of its coupled interest as the majority holder of senior secured debt.)

This case involves a complicated and lengthy transaction involving American HomePatient, Inc. (AHP), a publicly traded company that provides home health care services. Through a series of steps involving a debt repurchase, self-tender share offer and subsequent merger, Highland Capital Management effectuated a going-private transaction and became the owner of AHP. Immediately prior to this going-private transaction, Highland had acquired a 48% equity interest in AHP and 82% of AHPs senior secured debt. The debt was in default at the time of the going-private transaction. The plaintiff, Hamilton Partners, L.P., filed this case on behalf of AHP's other stockholders challenging the transaction and claiming that Highland, as controlling stockholder, breached its fiduciary duties because the transaction was not entirely fair.

Courts are often skeptical of the fairness of transactions between a corporation and its controlling shareholder because of the ability of the controlling shareholder to dictate terms. As a result, a controlling shareholder who either owns a majority of the corporation's stock or "exercises sufficient control over its business affairs" owes fiduciary duties to other shareholders. Hamilton Partners, 2014 WL 1813340 at *12. Whether a shareholder exercises sufficient control is a case-by-case analysis. In contrast, creditors do not owe any fiduciary duties to shareholders. Rather, obligations of creditors to corporate borrowers are governed solely by contract.

In this case, Hamilton Partners argued that Highland, as the slightlyless-than-majority stockholder with a 48% equity interest, was, in fact, the "controlling" shareholder by virtue of its additional role as the primary secured creditor. For purposes of ruling on Highland's motion to dismiss, where all reasonable inferences are drawn in the plaintiff's favor, the court agreed with Hamilton Partners. The court concluded that a reasonable inference existed that Highland, as both a shareholder and a creditor, exercised control over AHP to facilitate a transaction on unfair terms. Specifically, the court focused on Highland's behavior of entering into short-term forbearance agreements with respect to the debt while the going-private transaction was formalized and withholding consent to prevent AHP from refinancing its debt as supporting this inference. As a result, Highland's motion to dismiss was denied and the case will proceed to further pleading and factual analysis for determination of whether Highland was, in fact, a controlling shareholder who owes fiduciary duties to the other shareholders.

On the one hand, this case only involves the survival of a motion to dismiss where the court is required to draw all reasonable inferences in favor of the plaintiff. However, the possibility of a court elevating a minority stockholder to a controlling stockholder as a result of its related creditor status, and, as a result, subjecting the creditor to fiduciary duties, is troubling. This case will have important implications for lenders who also hold significant equity positions in their borrowers, tsl

JONATHAN HELFAT AND RICHARD KOHN

CFA CO-GENERAL COUNSEL

Jonathan N. Helfat, partner, Otterbourg P.C., and Richard M. Kohn, partner, Goldberg Kohn, are CFA co-general counsel.